Non-competes at center of legal battle between New York tech giant and San Francisco startup

Wednesday

Jul 23, 2014 at 6:00 AM

By Peter S. Cohan WALL & MAIN

Is it better to compete in the marketplace, or in the courts? I would tend to vote for competing in the marketplace. But if you're going to compete in the courts, one way that tech companies have been battling is over the differences in the enforcement of non-compete agreements California does note enforce them — New York and Massachusetts do.

In Massachusetts, big tech companies like EMC get employees to sign agreements that keep them from working for a competitor for two years after they leave. This makes it hard for startups to get going but it also helps protect big technology companies from training employees who leave and compete with them.

By contrast, California does not allow non-compete agreements — which is another element of its strategy to lure startups. To be sure, California has many other advantages over Massachusetts, the most notable of which are its much bigger pool of venture capital. In 2013, startups there received $12.3 billion in capital, almost four times the Massachusetts total.

This comes to mind in considering the legal battle between Islandia, N.Y.-based CA Technologies and San Francisco's AppDynamics — which provides application monitoring (APM) software as a service. Like its rival, New Relic both companies sprang out of Wily Technologies — which CA acquired for $375 million in 2006.

Chief executive officer Jyoti Bansal, who in April 2008 founded AppDynamics, told me in April that by 2024, CA would no longer be a public company. Instead, it would be broken into pieces and sold to private equity.

But a series of claims and counterclaims between CA and AppDynamics since June 2013 reveal that in addition to a he-said, she-said war of words being waged in the courts, there is a broader public policy issue at stake here — whether a New York company can impose that state's more restrictive non-compete rules to impede the growth of a California-based startup.

On July 21, 2014 CA sued AppDynamics, alleging that its founders developed its product while working for CA and asking a court for financial damages and an injunction to stop the company from misusing CA's intellectual property. AppDynamics claims that for years, its executives had been developing separate technology from CA's, and telling CA about it all along, from 2008 to 2014.

AppDynamics "strongly believes that these claims are untruthful and intentionally misleading. All AppDynamics code was written independently by its founders and is clearly protected under California law and public policy, including California Labor Code Section 2870," according to a July 21 press release.

AppDynamics believes that CA failed in its patent infringement case in New York so it tried a different path in California courts.

According to AppDynamics, "It is telling that CA first attempted to add these claims to its patent infringement lawsuit in New York, and that this attempt failed miserably when its motion was soundly thrown out by the court. AppDynamics then promptly filed a lawsuit in California to determine once and for all that CA's claims are without merit. Last Friday, CA filed its answer to AppDynamics'' complaint, which prompted CA's latest press release."

Before getting into the details of CA's latest complaint, let's take a look at the business over which the two are battling — APM. Gartner estimated that APM software, which helps companies keep track of how well their applications and websites are running and diagnoses problems, is a $2.9 billion market.

Gartner referred to AppDynamics as a leader in the APM space, and Mr. Bansal told me that the company was growing. In its fiscal year ending January 31, he said that AppDynamics customer count more than doubled from 500 to over 1,000 — among them are DIRECTV, NBC Universal, StubHub, Union Pacific, and Weight Watchers.

Moreover, AppDynamics was adding to its bookings and employee base at fast clips. Noted Mr. Bansal in April, AppDynamics' bookings grew at 175 percent with "an annualized bookings run-rate of more than $100 million in its fiscal fourth quarter. Our employee base grew from 150 to 450 in the last 15 months and we've raised $90 million from leading VCs (venture capitalists) such as Greylock Partners and Kleiner Perkins Caufield & Byers."

These two companies have been filing claims and counterclaims against each other since April 2013, when CA alleged that AppDynamics had violated three patents that it had obtained from Wily — which employed Mr. Bansal and AppDynamics' Chief Technology Officer and Senior Vice-President of Product Management, Bhaskar Sunkara.

In June 2013, AppDynamics answered CA's claims by denying that it had violated the patents.

And in an April 28, 2014 complaint for declaratory relief, AppDynamics argued that CA's claims had expired under California's statute of limitations, and that certain provisions of Mr. Bansal's and Mr. Sunkara's employment agreements violated California public policy.

"CA's threatened claims are meritless. Furthermore, CA's proposed claims are time-barred under California's statutes of limitations. Finally, certain provisions at issue in the agreements alleged to be breached are in violation of California public policy and are void," noted AppDynamics' April 28, 2014 complaint.

But in its July 21, 2014 complaint, CA alleges that Mr. Bansal and Mr. Sunkara, were each CA employees when they developed the software for AppDynamics.

Moreover, that complaint alleges that they had signed employment agreements with Wily in 2005, in which they agreed that they would not use Wily trade secrets during their employment at Wily and for five years after they left. CA asserted that it was Wily's "successor-in-interest" to these agreements.

CA's complaint alleges that Bansal and Sunkara started AppDynamics while they were CA employees — and after CA's 2006 acquisition of Wily, which made Introscope — a leading APM product, which Mr. Bansal and Mr. Sunkara helped build.

CA's complaint argues that Bansal and Sunkara misused its intellectual property and violated their employment agreement because they concealed that they were developing AppDynamics' product while they were CA employees.

But in its April 2014 filing, AppDynamics claimed that CA was aware that Mr. Bansal and Mr. Sunkara were working on the technology for their new company on their own time, using their own equipment.

Moreover, "on information and belief, CA has known that any such work was not performed for CA and was unrelated to its business or any actual or anticipated research and development at CA," according to AppDynamics' April 2014 filling. Nor did Mr. Bansal and Mr. Sunkara believe that had an obligation to assign their AppDynamics work to CA.

That same filing asserted that between 2008 and 2014, CA was aware of the work Mr. Bansal and Mr. Sunkara were doing and never asserted that they had misused CA's intellectual property or violated their employment agreement until that March 2014 complaint.

While it is unclear whether these legal skirmishes will have a material impact on AppDynamics, they do highlight a big competitive disadvantage of East Coast tech companies. Too often they do what CA is doing: Use the courts and enforcement of non-competes to block upstarts rather than reinventing their business.

Peter Cohan of Marlboro heads a management consulting and venture capital firm, and teaches business strategy and entrepreneurship at Babson College. His email address is peter@petercohan.com.

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